Abstract:
After the global financial crisis of 2008, the coordination between monetary and fiscal
policies gained increasing importance. This paper develops a macro econometric model
for a small open economy with monetary and fiscal coordination where market friction is
introduced and estimated by using the New Keynesian framework. Using Pakistani data,
the parameters are estimated for historical period ranging between 1975 to 2016. The
structural parameters estimation shows weak monetary and fiscal policy coordination.
Further evidence is gained from impulse response results which also confirmed weak
relationship as monetary and fiscal variables converged to equilibrium state after
sufficiently long lag. Based on this evidence, it is recommended that monetary and fiscal
sides need to focus on demand management policies to ensure price stability in the
economy. It is clear that fiscal policy has been a dominant force and despite
independence of the central bank, the monetary policy has been subservient to the fiscal
pressures. This requires strengthening of the monetary policy mechanism through
appropriate coordination platforms and accredited measures for appropriate statistics,
requisite assurances and appraisal of policy outcomes.
